Changes Coming For Big China ETF

As the largest and most heavily traded ETF tracking Chinese stocks, the iShares FTSE China 25 Index Fund (NYSE:FXI) has somewhat of a target on its back. Simply put, FXI is a case study in bigger not always being better with ETFs.

That much was highlighted in early October when China ETFs were showing signs of moving higher. Since then, FXI is up 1.7 percent, not accounting for Friday's losses.

As just two examples, the iShares MSCI China Index Fund (NYSE:MCHI) and the First Trust China AlphaDEX Fund (NYSE:FCA) sharply outperformed FXI over the past six months. Thinly traded and unheralded FCA has offered better than double the returns of FXI.

Still, investors, professional and retail alike, keep their respective torches burning for FXI. That despite the fact in its almost nine years of life, FXI has been frequently criticized for at least two other things beyond being a China ETF laggard.

Those being holding a small number stocks (currently 26) and an excessive weight to financials (currently 56.2 percent). The point being neither of those traits makes FXI an accurate representation of the world's second-largest economy.

After almost nine years of being dominated by state-controlled enterprises, FXI is set to change for the better, as IndexUniverse points out. The ETF's underlying index, the FTSE China 25 Index, last month made room to include Hong Kong-listed P-chips. P-chips are non-state run firms based outside of mainland China run by Chinese entrepreneurs, as IndexUniverse reports.

Bottom line: The inclusion of these companies in the FTSE China 25 Index should mean investors will be treated to a more diverse version of FXI following the ETF's next rebalancing.

Tencent Holdings, China's largest Internet company, and Belle International, the country's largest shoe retailer, have already made a home in the index, according to FTSE data.

And? Well, in a sign that news of potential changes to FXI are perhaps greatly overstated, there is no "and." Tencent and Bella are the only P-chips currently in the ETF's index and the two combine for less than 10 percent of the index's weight. Additionally, including those two companies does not mean FXI will have two more constituents.

Rather, as FTSE points out, Yanzhou Coal (NYSE:YZC) and Zijin Mining have been removed meaning the FTSE China 25 Index has, wait for it, 25 stocks.

Certainly, it is meaningful that FXI will eventually include Tencent and Belle, but there is no need for investors to wait around for the rebalance. MCHI's underlying index, the MSCI China Index, already includes P-chips. Tencent, Belle and others have already been constituents in that 139-stock ETF.

That is the same MCHI that is 12 basis points cheaper per year than FXI. The same MCHI that has outperformed FXI by fivefold over the past 12 months. It is nice that FXI is likely going to become a little more diverse, but China bulls need not wait for that event because MCHI is open for business.

For more on China ETFs, click here.